Replies to post #18192 on Advanced Micro Devices Inc (AMD)

[wbmw]

Alan, Re: Therefore, to make money on options requires you to be "smarter" than the market.

Maybe if you are just buying options, but I don't see it this way. If I'm bullish on a stock, sure I'll buy shares, but if I'm somewhat unsure, I'll use options to reduce my risk. I'll just sell some puts, which will allow me to buy the stock at a lower price if the stock goes down, or at least give me some free commission if the stock goes up. It's a win-win; the only thing I miss is lost opportunity, but I figure this is better than steering clear of the stock altogether.

Likewise, if I'm bearish on a stock, I'll sell, but if I'm unsure, I'll sell some calls. This way, if the stock goes up, I'll get to sell at a higher price; otherwise, at least I get the commission. Another win-win for me, with the only downside being lost opportunity if I'm wrong. Again, it could be better than avoiding the sale altogether.

[Elmer Phud]

Alan -

Therefore, to make money on options requires you to be "smarter" than the market. To make money on stocks requires you to be simply average.

These 2 statements are in conflict. If the average investor makes money in stocks then the long term trend must be up. If an options trader writes puts against a long term uptrend then he must benefit from the upward movement. The times where the market turns down and the put writer is assigned or otherwise closes his position can be viewed as dollar cost averaging. I see put writing as a useful strategy in a depressed market because I want to be buying anyway. Choose your stocks. Write puts against a company you are willing to own at the strike price.

[dougSF30]

Alan,

You also don't understand that you needn't be "smarter" than other poker players, because people use options for different reasons-- some EXPECT to lose a little money on options, and are using them to reduce risk, so they are happy with paying for the insurance. Others may buy options on speculation. With these sorts of arguments, I hope you own nothing other than index funds-- how dare you think you can beat the average by picking stocks...

I've seen this bizarre "zero-sum" argument crop up on other boards before... is there some book spouting this nonsense, or something? Where does this line come from?

Doug

[sgolds]

alan81 -

There was this group at Intel that "found out" about writing covered calls. They thought they had found this free money printing machine. The options always expired worthless and they had money in their pocket. Then one month came along where the stock had a HUGE run up. Should they give away their stock? ... They lost everything in that one month that they had made in the previous 12

No, that is not lost money - it is lost opportunity. A big difference! Opportunity can be made up in other ways. That is why I do not worry about the AMD shares that will be called from me this weekend at $11. I make money on those shares, and I make money from the covered call. In addition, I recouped my opportunity by purchasing calls long, and cashing in every few dollars the stock rises. I'm holding Dec 18s now, I pocketed all the profits from two lower options.

If I were simply holding shares long and the stock takes a dive then I am out unrealized value. However, since I've been taking my profits on options, if the stock dives to zero then I still walk away with a healthy profit.

Your friends lost profits because they simply wrote covered calls without studying options more fully. However, they did not lose money, they made a lower profit.

Note on gambling: The difference between gambling and trading is that gambling is based on a random result in a zero sum game while trading attempts to profit on the rise in value of a company, sector or economy as a whole. Not a zero sum game. When you purchase a call option, you are making a decision that the growth of the underlying security will be more than the cost of the purchase - the company is adding value. If you research your company and have reason to believe the value will rise then it is not gambling.

[HailMary]

requires you to be "smarter" than the market

I don't agree with you here. You don't have to be smarter in terms of what a stock will do, but you do have to be smart about the strategy and risks. Writing puts is perfect for someone with a nest egg they want to preserve. If you stick to a few simple rules, you can easily make over 10% a year. The keys are

1. write puts on a few different stocks you can follow closely that you would not mind owning
2. write puts that are well out of the money (below the current price of the stock)
3. write puts monthly that expire the next month
4. set a loss limit - I usually set this around 100% of the proceeds. For instance if I write a put for $.75 and it goes to $1.50, I'll buy it back, and reevaluate the underlying stock the next month for more put writing.

It takes some experience and willpower to do this, so I can't say it is for everyone. I find you can safely make around 2.5% of the money risked per month, and about 3 out the 12 months you'll have to buy back for a loss 100% (rule 4 above) or be assigned the shares. This works out to (2.5*12)-(3*2.5*2) = 15% per year. Some years are better (no buy backs are necessary), some are worse (more buy backs). Overall it is a more steady return than just buying stocks. I don't strictly follow the rules above, because often times I want to be assigned the stock for a long term hold, and obviously I'm risking some of the proceeds on speculation.

I'm also not big on covered calls. Often when it is time to sell, it is really time to sell for a reason. You don't want to chase a stock downwards trying to sell it. In your example the option writers should have allowed the shares to be called away, or at the very least set a loss limit like I suggested above. They would have still made money on their shares. There will always be opportunities to buy shares again.

This isn't arrogance. You can do better than average if you have the time and the will. Most people don't want to bother with the complexity, so they're happy with a lower return. I'm not one of those. I like to be involved in the process, and I get a better return for doing so.

HailMary

[UpNDown]

alan81, on options

Well said, and reflect my opinions as well. I like to simply buy stock while paying attention to paying minimum commissions (i.e. buy in chunks large enough so that the commission is negligible). That way, I believe I'm just hopping into a random spot onto the random walk upwards.

The other point, of course, is to buy in different industries and different geographical localities of interest to diversify. But for small investors reading this, don't attempt to diversify too early. Buy 500 to 1,000 AMD if you want, then, when you can, buy $10,000 to $20,000 of something else. If your interests are diverse enough, after 4 purchases you'll have diversified as much as needed to protect your equity capital.

[borusa]

Alan, ...Perhaps my attitude and opinion has more to do with my current situation than anything else. I am retired with a significant nest egg. My long term plan simply requires me to get an average of 6.5%/year return. I can be a below average investor in stocks and still hit my goal. To hit my goal with options requires me to be significantly above average. I am not so arrogant as to think I can execute better than others...
--Alan
msg# 18175
Great Post!